What Everyone Is Missing About The IMF's Latest World Economic Outlook

The International Monetary Fund (IMF) has released its updated
forecasts for the global economy, and it makes for grim reading.
Among the growth downgrades, however, is a point that most
commentators are overlooking: the real dangers of the oil-price
shock for Western economies.

Despite the tumbling of oil prices by over 50% since June,
providing a welcome boost to consumers through lower prices of
fuel and goods, the IMF has downgraded its forecast for global
growth by 0.3% this year and another 0.3% in 2016. The downgrades
reflect the ongoing weakness of the eurozone and Japan, as well
as slowing growth in emerging markets (especially among oil
exporters).

However, the report also contains a warning for advanced
economies such as those of the US and the UK that are seeing
relatively robust economic expansion. Lower oil prices are
helping drag down inflation and could mean that even
faster-growth economies experience a period of falling prices. If
this is allowed to continue unchecked, the IMF warns, it risks
becoming a self-feeding deflationary spiral.

With central bank interest rates already around zero, the ability
of monetary policy to offset these price falls and help bring
inflation back toward the 2% target is limited (at least
according to mainstream economic theory).

That is, the IMF is encouraging central banks to undertake
precautionary easing and, where that is unavailable because of
existing low interest rates, to use government spending on
infrastructure to increase economic activity and push up the rate
of price increases. Low government borrowing costs across much of
the developed world mean in effect that states have room to do
this at very limited (or even negative in the case of Germany and
Switzerland) cost to taxpayers, despite heavy debt burdens
following the financial crisis.

Not everyone is convinced. Numerous economists argue that a
temporary period of deflation because of a positive supply shock
— whereby prices are falling because more goods can be made for
the same amount of money — does not require any action from a
central bank. It should be a cause for celebration.

Many of those who hold this position also argue that
central banks can simply undertake further rounds of asset
purchases under their so-called quantitative easing programmes if
they become concerned that expectations of price falls are
becoming entrenched and people are holding off purchases.

However, the IMF's intervention can be seen as a
warning against the complacency of such a view. The
effectiveness of QE in reversing price falls remains a matter of
much debate in the economics profession and relying on
unconventional central bank tools to reverse price falls after
they have set in could be seen as too great a risk.